Income tax and pre-owned assets guidance section 1

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1. Outline of the charge to income tax

1.1 The circumstances in which the charge applies

Section 84 of the Finance Act 2004 gave effect to the provisions of Schedule 15 of that Act. The schedule provides for a charge to income tax on benefits received by a former owner of property. Broadly it applies to individuals (the chargeable person) who continue to receive benefits from certain types of property they once owned after 17 March 1986 but have since disposed of. The schedule has effect for the tax year 2005-06 and subsequent years.

The property within the scope of the charge can be grouped into three headings:

  • Land
  • Chattels
  • Intangible property

If the chargeable person has either disposed of any property within these headings by way of gift or, in some circumstances, sale, or contributed towards the purchase of the property in question and they continue to receive some benefit from the property they are potentially liable to the charge. The benefit may be occupation of the land, use of the chattel or the ability to receive income or capital from a settlement holding intangible property.

The preceding paragraph may suggest that every instance where an individual may have disposed of, or made a contribution to the purchase of, the relevant property will come within the scope of the charge. However, there are several types of transactions relating to land and chattels that are excluded from the scope of the charge. There are also provisions exempting the relevant property from the charge where the property is subject to a charge to inheritance tax or where specific protection from inheritance tax is given by legislation.

If the income tax charge applies the Schedule contains provisions enabling the taxable benefit to be calculated. In the case of the occupation or use of land and chattels the calculation of the taxable benefit will be determined to a large extent by the proportion which the value of the chargeable person's original interest in, or contribution to the purchase, bears to the current value of the property.

The following sections provide more detail on the conditions required for the charge to arise, where the transaction may be excluded or where the property is exempted, and how the benefit is calculated. All references to 'this Schedule' refer to Schedule 15 unless otherwise specified. References to 'the charge' refer to the charge to income tax arising under Schedule 15.

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1.2 What property is affected?

The conditions required for the charge to apply are virtually identical where the property in question is land or chattels but they differ slightly in respect of intangible property.

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1.2.1 Land and chattels

The charge applies where the chargeable person occupies any land or uses or possesses any chattels, either alone or with other persons, and either the 'disposal condition' or the 'contribution condition' is met. Paragraphs 3 and 6 of this Schedule define the conditions.

The disposal condition

The disposal condition will apply if the chargeable person, at any time after 17 March 1986, owned relevant land or chattels, or other property whose disposal proceeds were directly or indirectly applied by another person towards the acquisition of the relevant land or chattels, and then disposed of all or part of their interest in the relevant land or chattels (or other property). If the disposal was an excluded transaction (see 1.3.1) the disposal condition will not apply.

Note that the disposal condition will apply to the chargeable person's occupation or use of property even if that property was never actually owned by them. If they gave away other property (apart from cash) to another person who sold such property and used these proceeds to purchase the relevant land or chattel the disposal condition is satisfied, unless it qualifies as an excluded transaction.

A disposition that creates a new interest in land or in a chattel out of an existing interest is taken to be a disposal of part of the existing interest.

The contribution condition

The contribution condition will apply if the chargeable person, at any time after 17 March 1986, provided any of the consideration given by another person for the acquisition of an interest in the relevant land or chattel, or for the acquisition of any other property the proceeds of the disposal of which were directly or indirectly applied by another person towards an acquisition of an interest in the relevant land or chattel. As with the disposal condition, if the provision of the consideration qualifies as an excluded transaction, this condition will not apply.

It can be seen that the contribution condition can apply not only where the contribution provided by the chargeable person is directly used to purchase the relevant land or chattel but where the contribution is indirect too. If they provided all or part of the consideration (eg. a cash gift) for the purchase of property by another person, who then sold the property and used the proceeds to purchase the land occupied, or the chattel used, by the chargeable person, the contribution condition is satisfied, unless it qualifies as an excluded transaction (see 1.3.1).

HMRC do not regard the contribution condition set out in Schedule 15, para 3(3) as being met where a lender resides in property purchased by another with money loaned to him by the lender. Our view is that since the outstanding debt will form part of his estate for IHT purposes, it would not be reasonable to consider that the loan falls within the contribution condition [and therefore not reasonably attributable to the consideration (Sch 15, para 4(2)(c)], even where the loan was interest free. It follows that the 'lender', in such an arrangement, would not be caught by a charge under Schedule 15.

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1.2.2 Intangible property

In contrast to the provisions relating to land and chattels there is only one condition to be met for the charge to apply. Paragraph 8 of this Schedule defines the condition.

The charge extends to intangibles that are or represent property settled or added by the chargeable person to a settlement after 17 March 1986 on terms that any income arising from the settled property would be treated under section 624 ITTOIA 2005 (income arising under a settlement where the settlor retains an interest) as income of the chargeable person as settlor and any such income would be so treated even if subsection (2) of that section did not include any reference to the spouse of the settlor. In other words, a charge under paragraph 8 is not triggered where section 624 applies only because the settlor's spouse rather than the settlor has retained an interest. The settlor in this case is, of course, the chargeable person. For example if A sets up a trust for his wife on marriage and he is excluded from all benefit there is no possibility of paragraph 8 applying. However, if he sets up a trust where his wife receives the income but he can benefit if she dies then para 8 could potentially apply subject to any relevant exemptions.
In this context 'settlement' has the same meaning as it does for inheritance tax purposes. The definition of 'settlement' can be found in section 43(2) Inheritance Tax Act 1984. The fact that there is no element of bounty does not matter.

Intangible property means assets such as stocks and securities, insurance policies and bank and building society accounts. The provisions of this paragraph do not apply to land and chattels included in a settlement.

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1.3 When the charge does not apply

There are a number of situations where a charge to tax under Schedule 15 will not arise. Certain transactions are excluded from the charge and there are also exemptions from the charge where certain conditions are met.

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1.3.1 Excluded transactions (Sch 15 para 10)

The concept of excluded transactions has no application to intangible property. They only serve to exclude from the income tax charge certain transactions relating to land and chattels.

For the purposes of the disposal conditions relating to land and chattels, the disposal of any property is an excluded transaction in relation to the chargeable person if

  • It was a disposal of their whole interest in the property, except for any right expressly reserved by them over the property, either
    i. by a transaction made at arm's length with a person not connected with them, or
    ii. by a transaction such as might be expected to be made at arm's length between persons not connected with each other.

The exclusion clearly only applies to sales of the entire interest in the property at full market value although the words "except for any right expressly reserved" would envisage the sale of a freehold reversion subject to a lease but only if it was on arms length terms.

Concern was expressed that sales of a part share of property to commercial providers of equity release schemes would not qualify as an excluded transaction and an individual would be subject to the charge if he remained in occupation of the land. This concern was recognised in the Regulations to the charge which specifically exempted from the charge disposals of part of an interest in any property by a transaction made at arm's length with a person not connected with the chargeable person. Furthermore, the exemption is extended to disposals of a part share to anyone provided that they were made on arm's length terms and either took place before 7 March 2005, or took place on or after that date for a consideration not in the form of money or assets readily convertible into money.

  • The property was transferred to their spouse or civil partner, or former spouse or civil partner where the transfer has been ordered by a court.
  • The disposal was by way of gift (or in accordance with a court order for the benefit of a former spouse or civil partner) by virtue of which the property became settled property in which his spouse or civil partner or former spouse or civil partner is beneficially entitled to an interest in possession. The spouse or civil partner must take an interest in possession from the outset. It is not an excluded transaction, however, if the interest in possession of the spouse or civil partner or former spouse or civil partner has come to an end other than on their death. In cases where the spouse or civil partner or former spouse or civil partner has become absolutely entitled to the property, we would accept that the benefit of the exclusion is not lost.
  • The disposal was a disposition falling within section 11 Inheritance Tax Act 1984 (disposition for maintenance of family).
  • The disposal is an outright gift to an individual and is for the purposes of the Inheritance Tax Act 1984 a transfer of value that is wholly exempt by virtue of section 19 (annual exemption) or section 20 (small gifts).

For the purposes of the contribution conditions relating to land and chattels, the provision by the chargeable person of consideration for another's acquisition of any property is an excluded transaction in relation to the chargeable person if

  • The other person was their spouse or civil partner, or former spouse or civil partner where the transfer has been ordered by a court.
  • On its acquisition the property became settled property in which their spouse or civil partner or former spouse or civil partner is beneficially entitled to an interest in possession. The spouse or civil partner must take an interest in possession from the outset. It is not an excluded transaction, however, if the interest in possession of the spouse or civil partner or former spouse or civil partner has come to an end otherwise than on their death unless the spouse or civil partner or former spouse or civil partner has become absolutely entitled to the property.
  • The provision of the consideration constituted an outright gift of cash by the chargeable person to the other person (in this context the "other person" means the person referred to in paragraphs 3(3) and 6(3)) and was made at least 7 years before the earliest date on which the chargeable person occupied the land or had possession or use of the chattel As the earliest date the conditions can be met is 6 April 2005, any provision of consideration by way of an outright gift of cash made before 6 April 1998 will be an excluded transaction.
  • The provision of the consideration is a disposition falling within section 11 of the Inheritance Tax Act 1984.
  • The provision of the consideration is an outright gift to an individual and is for the purposes of the Inheritance Tax Act 1984 a transfer of value that is wholly exempt by virtue of section 19 or section 20.

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1.3.2 Exemptions from the charge (Sch 15 para 11)

Property in the estate (para 11(1)) exemption

The charging provisions in schedule 15 relating to land, chattels and intangible property do not apply to a person at a time when their estate for the purposes of the Inheritance Tax Act 1984 includes the relevant property, or other property which

  • derives its value from the relevant property, and
  • whose value so far as attributable to the relevant property, is not substantially less than the value of the relevant property.

Where their estate includes property which derives its value from the relevant property and whose value, so far as attributable to the relevant property, is substantially less than the value of the relevant property

  • the appropriate rental value of the relevant land, or
  • the appropriate amount in respect of the chattel, or
  • the chargeable amount in relation to the relevant intangible property
    must be reduced by such proportion as is reasonable to take account of the inclusion of the property in their estate.

For example if Mr B transfers his house to a company wholly owned by him, then provided there are no loans to the company one can say that the value attributable to the company is not less than the value of the house. But if Mr B gave the house to a company which was owned 25% by his wife then the value of the 75% shares he holds would be substantially less than the value of the house. If he has lent money to the company and the company holds the house we take the view that the company's value is less than the house unless (possibly) the loan is charged on the house.

Gifts with reservation Para 11(3) exemption.

The charging provisions also do not apply to a person at a time when, for IHT purposes, the relevant property or property deriving its value from relevant property falls within the Gifts with Reservation provisions set out in Finance Act 1986.

The provisions of Schedule 15 are also disapplied if the property

  • would fall to be treated as subject to a reservation but for any of sections 102(5)(d) to (i) of the Finance Act 1986 (certain cases where disposal by way of gift is an exempt transfer for purposes of inheritance tax). But where s.102(5)(h) is in point, Schedule 15 is disapplied only when the property remains subject to trusts complying with the requirements of Schedule 4, para 3(1) Inheritance Tax Act 1984 (maintenance funds),
  • would fall to be treated as subject to a reservation but for subsection (4) of section 102B of the Finance Act 1986 (gifts with reservation: share of interest in land), or would have fallen to be so treated if the disposal by way of gift of an undivided share of an interest in land had been made on or after 9 March 1999. This refers to situations where the chargeable person transfers a share (usually 50%) of their property to the donee and both the donee and the chargeable person continue to occupy the property, paying their share of household expenses, or
  • would fall to be treated as subject to a reservation but for section 102C(3) of, and paragraph 6 of Schedule 20 to, the Finance Act 1986 (exclusion of benefit). This refers to situations where the chargeable person continues to use or occupy the property but pays full consideration in money or money's worth, or where they leave the property but have to move back at a later date due to an unforeseen change in their circumstances and are unable to look after themselves because of age or infirmity.

Where the contribution condition relating to land or chattels applies, paragraph 2(2)(b) of Schedule 20 (which excludes gifts of money from the provisions that apply where property is substituted for the original gift) should be disregarded. For example, if A gives cash to his son and they buy a home jointly and live together then while they live together, the POAT charge will not apply.

Schedule 15 also contains provisions for the chargeable person to elect that the relevant property that would otherwise be subject to the charge be treated as property subject to a reservation for the purposes of the Inheritance Tax Act 1984. If the election is made no charge under the Schedule will apply. Full details of these provisions are given in part 3 of these notes.

Excluded liability

Where at any time the value of a person's estate for the purposes of the Inheritance Tax Act 1984 is reduced by an 'excluded liability' affecting any property, only the excess of the value of the property over the amount of the excluded liability can be treated as comprised in their estate for the purposes of this schedule.

A liability is an excluded liability if

  • the creation of the liability, and
  • any transaction by virtue of which the person's estate came to include the relevant property or property which derives its value from the relevant property or by virtue of which the value of the property in their estate came to be derived from the relevant property,
    were associated operations, as defined by section 268 of the Inheritance Tax Act 1984.

The "amount" of the excluded liability will be the face value of the debt, including any rolled up interest or accrued indexation where this has been allowed for under the terms of the agreement. For the purposes of computing the charge under this schedule, it will be sufficient for the debt to be revalued taking into account outstanding interest, or accrued indexation, at the 5 yearly valuation dates. Any reduction of the debt resulting from a repayment can be taken into account as it occurred, and may be reflected in a revised computation of the tax in the relevant year and subsequently.

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1.3.3 Residence or domicile outside the United Kingdom (Sch 15 para 12)

No charge to tax under this Schedule can arise in relation to any person for any year of assessment during which they are not resident in the United Kingdom.

If a person is resident in but domiciled outside the United Kingdom in any year of assessment, the provisions of this Schedule will only apply to land, chattels or intangible property situated in the United Kingdom.

In applying this Schedule to a person who was at any time domiciled outside the United Kingdom, no regard should be had to any property which is for the purposes of the Inheritance Tax Act 1984 excluded property in relation to them by virtue of section 48(3)(a) of that Act.

A person is to be treated as domiciled in the United Kingdom at any time if they would be so treated for the purposes of the Inheritance Tax Act 1984. Hence the deemed domicile rules will apply for the purposes of this income tax charge.

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1.3.4 De minimis exemption (Sch 15 para 13)

An exemption from charge under this Schedule applies where in relation to any person in a year of assessment (example 1), the aggregate of the amounts specified below in respect of that year do not exceed £5,000 (example 2). Those amounts are

  • in relation to any land to which paragraph 3 applies, the appropriate rental value as determined under paragraph 4(2) – see 2.1 below,
  • in relation to any chattel to which paragraph 6 applies, the appropriate amount as determined under paragraph 7(2) – see 2.2 below, and
  • in relation to any intangible property to which paragraph 8 applies, the chargeable amount determined under paragraph 9 – see 2.3 below.

Example 1:

The £5,000 is based on the chargeable amount for the year. So if a person is chargeable throughout the whole tax year and the annual benefit is calculated at £5,000 or less they do not have to declare the benefit on their income tax return. If a person is chargeable for only part of the year, say they only become chargeable for the last six months of the year where the full annual benefit would be £8,000, their exposure for the last six months is half that and the benefit of £4,000 would be covered by the de minimis. Where two people are equally chargeable for the whole year in respect of the same property, for example a property with an annual rental value of £8,000, their benefit would be £4,000 each and would be covered by the de minimis. (On the death of one, you should consider former ownership of the property, and the terms of occupation, in deciding whether the whole or a half of the rental value is chargeable on the survivor).

Example 2:

a person is chargeable under Para 3 for a benefit from land with an annual value of £4,000 and under Para 6 for a benefit from a chattel with an annual value of £3,000. The aggregate benefit is £7,000 and therefore not de minimis. If, in this example, an annual rental of £4,000 is paid to obtain the aggregate benefit, although the net benefit is £3,000 it is not de minimis because the annual open market rental value exceeds £5,000 and therefore the amount of the benefit (£3,000) would need to be declared. A person cannot avoid the tax charge by paying an annual rent to bring himself below £5000.

The de minimis is set against the annual benefit for intangible property after deduction of any tax paid under the headings of Para 9(1) of Schedule 15.

Example:

A person benefits from a settlor interested trust where the benefit is calculated to £7,000 (N). The fund generates income on which tax of £3,000 (T) is payable. The net amount of the benefit (N-T) is £4,000 and is de minimis.The amount of £5,000 does not represent a nil-rate band, therefore where the aggregate chargeable value exceeds £5,000 it is subject to the charge in full.
When a taxpayer is chargeable for only part of a year, the £5,000 exemption is not pro-rated.

Where the de minimis exemption under paragraph 13 is not exceeded the transferor cannot make an election because he is not chargeable to income tax under Schedule 15.

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1.3.5 Changes in the distribution of a deceased's estate (Sch 15 para 16)

Any disposition made by the chargeable person in relation to an interest in the estate of a deceased person is disregarded for the purposes of this Schedule if under section 17 Inheritance Tax Act 1984 the disposition is not a transfer of value by the chargeable person for IHT purposes. All dispositions covered by section 17, including disclaimers and variations where the provisions of section 142(1) Inheritance Tax Act 1984 apply, will be exempted from the charge by paragraph 16 of this schedule. [see Appendix 1 example]

For the purposes of this paragraph 'estate' has the same meaning as it has for the purposes of the Inheritance Tax Act 1984.

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1.3.6 Guarantees (Sch 15 para 17)

Where a person ("A") acts as a guarantor in respect of a loan made to another person ("B") by a third party in connection with B's acquisition of any property, the mere giving of the guarantee is not regarded as the provision by A of consideration for B's acquisition of the property.